Is it time to buy a discount on this 8.1% hyper-yielding dividend king?

Most investors who buy Altria Group (NYSE: MO) stocks do not in hopes of enjoying explosive share price gains. The stock underperformed S&P 500 for years. What about the dividend? That’s another story. Altria is a world-class dividend stock with a massive yield and a history of growing payouts spanning more than five decades.

The king of dividends has shown some life this year. This month, the stock climbed above $56 to its highest price since early 2022 before retreating to around $50.

This pullback could make this a perfect buying opportunity for dividend-hungry investors looking for double-digit annual percentage returns on their investments.

Slow. Stable. Reliable.

Many investors view tobacco companies as the old guard of the stock market. US smoking rates have been declining for decades, and it is well known how terrible tobacco use of any kind is for one’s health. Altria, which sells cigarettes, chewing tobacco and smokeless nicotine products in the United States, still derives the vast majority of its revenue and income from selling cigarettes. Marlboro is Altria’s flagship brand.

But even today, people seem to underestimate how resilient the tobacco industry is. The addictive nature of nicotine and the high regulatory barriers to new industry entrants have allowed Altria to consistently raise its prices per pack, more than making up for the fact that Altria sells fewer cigarettes each year.

The combination of these price increases and the company’s share repurchases was enough to increase Altria’s free cash flow per share overall.

No one will mistake Altria for a high-growth business. Its earnings are growing at low single-digit percentage rates. The bottom line is that it continues to deliver slow and steady growth. Will this go on forever? No one can know for sure. However, there are no signs of it stopping anytime soon. Analysts estimate that Altria will increase its revenues by a little over 3% annually in the next three to five years.

This is not a yield trap

A company’s management team can choose how much it pays out in dividends, but it can’t fully control its dividend yield because that also depends on the stock price. Sometimes high returns can tempt investors — they can look like easy money. However, a stock’s dividend yield could be high because the market believes the company can’t afford to maintain its payout at previous levels, or because other red flags are driving the stock price lower.

In this context, high-yielding stocks can turn out to be bad investments, especially if the company cuts its dividend. Such low-quality, high-yielding stocks that are headed for payout discounts are sometimes called yield traps.

The story continues

Altria’s dividend yield is high because its earnings are growing slowly. The market knows that most of the stock’s return will come from dividends, and the stock price reflects this. However, Altria is not a yield trap because its payout is secure. The company typically spends about 80% of earnings on dividends.

That’s a higher dividend payout ratio than most companies, but Altria’s business requires little investment. Can’t even advertise because of tobacco laws. This unique business model allows Altria to comfortably distribute more of its profits in the form of dividends than most companies.

Market-beating investment returns are possible

Altria has been around for generations and is one of the best performing stocks ever. However, it underperformed S&P 500 for years. However, it could once again become a market-beating stock.

Thanks in large part to the AI ​​trend, the S&P 500 has enjoyed a stellar 31% gain over the past year and trades at a price-to-earnings (P/E) ratio of 24, well above its historical average. While trying to time the market tends to be a losing strategy, there could be more volatility ahead and if a US recession occurs, it could trigger a market decline.

Altria, meanwhile, has a fairly straightforward path to double-digit annualized investment returns. Based on its current dividend yield of 8.1% and expectations for annual earnings growth of 3% to 4%, it could yield between 11% and 12% annually. With a P/E ratio below 9, Altria’s valuation is reasonable enough that investors are less likely to see a further dramatic decline in the stock’s valuation. Now that the Federal Reserve has started to cut interest rates, the market could even support higher valuations for high-yield stocks like Altria.

Altria stock can deliver reliable dividends and even surprise investors with its total return potential. Its slow growth means investors shouldn’t overpay for the stock, so its recent decline provides a perfect opportunity to add shares while the stock price makes sense.

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Justin Pope has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Is it time to buy a discount on this 8.1% hyper-yielding dividend king? was originally published by The Motley Fool